Globalization and the Current Financial Crisis in Historical
Perspective – A Tale of two crises
Nathan Sussman and Yishay Yafeh
Hebrew University and CEPR
Motivation and Methodology
• Many theories ‘explain’ current crisis
• Use the past to sort the culprits out of the
‘usual suspects’ in the present
• Rediscover the past using the present.
Why Baring 1890?
• Had all the makings similar to the subprime crisis:
1. Globalization and global financial system
2. Post industrial economy expanding its financial sector
3. Practically unregulated financial system 4. The (probably) largest bank in the world
exposed to defaulting assets
5. Potential disastrous impact on British financial system
Preliminary conclusions
Popular explanations 1. Globalization
2. “The end of capitalism”
3. Limited regulation 4. Moral Hazard
All Existed in 1890 – but no worldwide crisis
Baring Crisis in 3 (long) sentences
• Baring 1890 – the world largest investment bank.
Heavily exposed and underwrote Argentinean debt
• Debt funded real estate bubble in Argentina – defaulted provincial debt assumed by national government that then defaulted owing to
bursting of sovereign lending bubble in London
• Baring on verge of default saved by Bank of
England – short lived financial crisis for UK – not so short for Argentina
Is the comparison relevant?
Table 1: The Macroeconomic Magnitudes of the Baring Crisis and the Current Crisis
UK figures in millions of pounds, US figures in billions of US dollars. Problematic assets are defined as defaulted mortgage-based securities, 2007-8 figures based on reports in the financial press, e.g. Bloomberg, May 17, 2008.
Baring Crisis Sub-prime Crisis
UK GDP 1,442 US GDP 14,061
Value of Latin American debt 140 Value of sub-prime related assets
1,400 Latin American debt relative to
GDP
9.8% Sub-prime related assets relative to GDP
10.0%
Value of Argentinean bonds 49 Value of problematic sub- prime assets
475 Argentinean bonds relative to
GDP
3.4% Problematic sub-prime assets relative to GDP
3.3%
Value of Baring’s balance sheet
“difficulties”
21 Value of Lehman Brothers’
problematic balance sheet assets
175
Baring’s balance sheet
“difficulties” relative to GDP
1.5% Lehman Brothers’ problematic balance sheet assets relative to GDP
1.2%
0 20 40 60 80 100 120 140
t-60 t-55 t-50 t-45 t-40 t-35 t-30 t-25 t-20 t-15 t-10 t-5 t t+5 t+10 t+15 t+20
The price of underlying asset prices - Subprime and Aregntina 5 years before to two years after
Case Shiller housing price index Argentina bond price Sources: FRED, IMM (various issues)
Monthly data
0 1 2 3 4 5 6 7
t-90 t-87 t-84 t-81 t-78 t-75 t-72 t-69 t-66 t-63 t-60 t-57 t-54 t-51 t-48 t-45 t-42 t-39 t-36 t-33 t-30 t-27 t-24 t-21 t-18 t-15 t-12 t-9 t-6 t-3 t t+3 t+6 t+9 t+12 t+15 t+18 t+21 t+24 t+27 t+30 t+33 t+36
percent
Chart 4
90-Day Commercial Paper Rates: London and New York
3 Month commercial paper New York 3 Month commercial paper London Sources: FRED , IMM (various issues)
Monthly data ; Monthly average t = 11/1890 and 7/2007
A short lived crisis
Table 2: Collapse and Recovery of Bonds Prices – November 11 to November 27, 1890
Source: Investor’s Monthly Manual, December 31, 1890
Country/ bond Price on November 11th
Price on November 19th
Percent change
Price on November 27th
Percent change Argentina 1884 5% 80.00 67.50 -15.6 75.00 +11
Brazil 1889 4% 89.00 77.00 -13.5 81.00 +5.2
Mexico 6% 91.50 86.00 -6.0 92.00 +7.0
Uruguay 5% 53.00 39.00 -26.4 54.00 +38.5
Greece 1881-4 5% 89.25 86.50 -3.1 91.00 +5.2
Hungary Gold rentes 89.50 87.50 -2.2 89.50 +2.3
Italy 5% rentes 92/00 91.00 -1.1 92.50 +1.6
Portugal 3% 56.25 53.75 -4.5 56.25 +4.6
Russia 4% 97.50 96.75 -0.8 97.00 +0.3
The classical explanation
• Central bank intervention was done right then vs. now:
• “The past month will long be remembered in the City.
The downfall of … Baring… perhaps the greatest firm of merchant banking in the world… but it will be even more distinguished by the fact that a crisis of the
gravest character has been averted by the action of the Bank of England, aided by joint-stock and other banks”
(Investor’s Monthly Manual, November 29, 1890, p.
564).
2 2,5 3 3,5 4 4,5 5 5,5 6 6,5
10000000 15000000 20000000 25000000 30000000 35000000 40000000 45000000 50000000 55000000 60000000
1/1/1890 1/22/1890 2/12/1890 3/5/1890 3/26/1890 4/16/1890 5/7/1890 5/28/1890 6/18/1890 7/9/1890 7/30/1890 8/20/1890 9/10/1890 10/1/1890 10/22/1890 11/12/1890 12/3/1890 12/24/1890 1/14/1891 2/4/1891 2/25/1891 3/18/1891 4/8/1891 4/29/1891 5/20/1891 6/10/1891
Pounds
Chart 6
Bank of England Intervention During the Baring Crisis
Credit Monetary base Deposits+reserves Bank Rate (right axis) Source: The Times
Weekly data, end of week
0 1 2 3 4 5 6 7
1/1/1890 1/15/1890 1/29/1890 2/12/1890 2/25/1890 3/12/1890 3/26/1890 4/9/1890 4/23/1890 5/7/1890 5/21/1890 6/4/1890 6/18/1890 7/2/1890 7/16/1890 7/30/1890 8/13/1890 8/27/1890 9/10/1890 9/24/1890 10/8/1890 10/22/1890 11/5/1890 11/19/1890 12/3/1890 12/17/1890 12/31/1890 1/14/1891 1/28/1891 2/11/1891 2/25/1891 3/11/1891 3/25/1891 4/8/1891 4/22/1891 5/6/1891 5/20/1891 6/3/1891 6/17/1891
percent
Chart 7
London and Paris 90- day Market Rates
London market rate Paris market rate bank rate Sources: IMM
Weekly Data; end of week
Central bank reaction - summary
Then
• Bank of England intervened immediately
• Effective in preventing worldwide liquidity crisis
• Immediate effect on money market Now
• FED let Lehman fail
• Intervened massively thereafter
• world money markets affected slowly
Looking elsewhere - contagion
Contagion and co-movement - summary
Then
• Less co-movement
• Pre-crisis – “the tide lifts all boats”
• During crisis – investor discriminate between assets based on exposure to fundamentals Now
• More co-movement
• Pre-crisis – “the tide lifts all boats”
• During crisis – severe contagion.
